“The crash has
laid bare many unpleasant truths about the
United States. One of the most alarming is that
the finance industry has effectively captured
our government”, says Simon Johnson, a chief
economist with the International Monetary Fund
in 2007 and 2008. In an article entitled “The
Quiet Coup” in the May, 2009 issue of the
Atlantic magazine he (with James Kwak) goes on
to say that “if the IMF’s staff could speak
freely about the U.S., it would tell us what it
tells all countries in this situation: recovery
will fail unless we break the financial
oligarchy that is blocking essential reform”.

How true! America is in financial crisis but
instead of the financial oligarchy being broken
up to permit essential reform they are
continuing to use their influence to prevent
precisely the sorts of reforms that are needed
immediately to pull the economy out of its
nosedive. Unfortunately, our legislators seem
unwilling to act against these powerful
financiers opting instead to succumb to their
power and influence and continue to give them
what they deem to be in their best interest
instead of that of the taxpayers’. All this is
happening because of the false belief by all
concerned that large financial institutions and
free-flowing capital markets are crucial to
America’s position in the world and that
whatever the banks say is true and what they
want is necessary. The government’s velvet-glove
approach with the banks is deeply troubling, for
one simple reason: it is inadequate to change
the behavior of a financial sector accustomed to
doing business on its own terms, at a time when
that behavior must change. There is no better
time to take such action than now but it is
evident that reform is but a pipe dream.
America’s financial oligarchy is still in
control and, as such, the long-term consequences
will be dire!

The Powerful Elites have Over-reached

Johnson says that (and I paraphrase an edited
version of ‘The Quiet Coup’ article in the
following pages) typically countries in crisis
are in a desperate economic situation for one
simple reason—the powerful elites within them
overreached in good times and took too many
risks. That certainly is the case with the
powerful elites - the financial oligarchy - in
America. In the case of the U.S. economic and
financial crisis, global investors, afraid that
the country or its financial sector wouldn’t be
able to pay off mountainous debt, suddenly
stopped lending. That fear became
self-fulfilling, as banks that couldn’t roll
over their debt did, in fact, become unable to
pay and this weakness in the banking system
quickly rippled out into the rest of the
economy, causing a severe economic contraction
and hardship for millions of people.

Financial Industry has Gained Political Power

The American financial industry gained political
power over the years by amassing a kind of
cultural capital, a belief system in which
Washington insiders believe that large financial
institutions and free-flowing capital markets
are crucial to America’s position in the world …
and always and utterly convinced that whatever
the banks said was true.

Of course, this was mostly an illusion.
Regulators, legislators, and academics almost
all assumed that the managers of these banks
knew what they were doing. In retrospect, they
didn’t.

As more and more of the rich made their money in
finance, the cult of finance seeped into the
culture at large. In a society that celebrates
the idea of making money, it was easy to infer
that the interests of the financial sector were
the same as the interests of the country and
that the winners in the financial sector knew
better what was good for America than did the
career civil servants in Washington. Faith in
free financial markets grew into conventional
wisdom—trumpeted on the editorial pages of The
Wall Street Journal and on the floor of
Congress.

From this confluence of campaign finance,
personal connections, and ideology there flowed,
in just the past decade, a river of deregulatory
policies that is, in hindsight, astonishing.

The mood that accompanied these measures in
Washington seemed to swing between nonchalance
and outright celebration: finance unleashed, it
was thought, would continue to propel the
economy to greater heights.

America’s Oligarchs and the Financial Crisis

While many other factors contributed to the
financial crisis that exploded last year,
including excessive borrowing by households and
lax lending standards, major commercial and
investment banks—and the hedge funds that ran
alongside them—were the big beneficiaries of the
twin housing and equity-market bubbles of this
decade. Each time a loan was sold, packaged,
securitized, and resold, banks took their
transaction fees, and the hedge funds buying
those securities reaped ever-larger fees as
their holdings grew. (See the article I wrote
entitled “Our Worst Nightmare: The Puncture of
the U.S Housing Bubble” back in early 2006 for a
detailed account on just how such loans were
handled.)

Because everyone was getting richer, and the
health of the national economy depended so
heavily on growth in real estate and finance, no
one in Washington had any incentive to question
what was going on.

When the crisis first began the government was
slow to react and then did so with a lack of
transparency, and an unwillingness to upset the
financial sector. The response so far is perhaps
best described as “policy by deal” in that when
a major financial institution got into trouble,
the Treasury Department and the Federal Reserve
engineered a one-of bailout and then announced
that everything is fine without stating what
combination of interests were being served, and
how. This was late-night, backroom dealing, pure
and simple.

Throughout the crisis, the government has taken
extreme care not to upset the interests of the
financial institutions, or to question the basic
outlines of the system that got us here. This
velvet-glove approach is inadequate to change
the behavior of a financial sector accustomed to
doing business on its own terms, at a time when
that behavior must change.

The Way Out

We face at least two major, interrelated
problems. The first is a desperately ill banking
sector that threatens to choke off any incipient
recovery that the fiscal stimulus might
generate. The second is a political balance of
power that gives the financial sector a veto
over public policy, even as that sector loses
popular support.

Big banks, it seems, have actually gained
political strength since the crisis began and
this is not surprising. With the financial
system so fragile, the damage that a major bank
failure could cause is much greater than it
would be during ordinary times. The banks have
been exploiting this fear as they wring
favorable deals out of Washington. (See
reference to the new mark-to-market legislation
below as a case in point.)

The challenges the United States faces are
familiar territory to the people at the IMF.

If you hid the name of the country and just
showed them the numbers, there is no doubt what
old IMF hands would say:

nationalize the banks,
limit individual bank size,
update antitrust legislation,
cap executive compensation,
improve banking regulations,
increase taxation,
increase transparency and
increase competition.
(Regretfully, none of the above remedies are
going to happen any time soon, if ever. Take a
look at what happened just last week on April
2nd, 2009. The financial oligarchy’s lobby
group, the American Bankers Association, was
successful in having political pressure brought
to bear, by legislators from both parties,
against the Financial Accounting Standards Board
to do their bidding which now gives banks more
discretion in reporting the value of mortgage
securities. These new mark-to-market rules will
enable all financial institutions with such
securities to report higher profits by assuming
that the securities are worth more than anyone
now is prepared to pay for them i.e. avoid
recognizing losses from bad loans that they had
made. As a result of having their way the
financial institutions affected are now free to
apply the new rules to their financial
statements for the quarter that ended on March
31st. How convenient!)

If no remedies are going to be initiated what
does the future hold. According to Johnson it
includes a global economy continuing to
deteriorate and the collapse of the banking
system in east-central Europe and then
throughout the Continent This dramatic worsening
of the global environment would force the U.S.
economy, already staggering, down onto both
knees and perhaps then, under this kind of
pressure, and faced with the prospect of a
national and global collapse, the American
people will demand in no uncertain terms that
their government finally break up the financial
oligarchy and implement the abovementioned
reforms.

Unfortunately, Johnson concludes, “the
conventional wisdom among the elite is still
that the current slump cannot be as bad as the
Great Depression. This view is wrong. What we
face now could, in fact, be worse than the Great
Depression because the world is now so much more
interconnected and because the banking sector is
now so big. We face a synchronized downturn in
almost all countries, a weakening of confidence
among individuals and firms, and major problems
for government finances”.

If our leadership wakes up to the potential
consequences, we may yet see dramatic action on
the banking system and a breaking of the old
elite. There is no better time to take such
action than now but it is evident that reform is
but a pipe dream. America’s financial oligarchy
is firmly in control and, as such, the long-term
consequences will be dire!

What should one do knowing what to expect in the
years to come? I think it is safe to recommend
having some gold bullion (preferably some gold
coins) on hand as insurance against a potential
systemic fiscal collapse. Such a debacle may be
a few years off but in an economic environment
like this I think you would agree that it is
better to be safe than sorry.

Simon Johnson is a former chief economist with
the International Monetary Fund and is currently
a professor at the MIT Sloan School of
Management and a senior fellow at the Peterson
Institute for International Economics. He, along
with James Kwak, a former McKinsey consultant,
is a co-founder of The Baseline Scenario (www.baselinescenario.com)
which is a blog dedicated to explaining what
happened in the global economy and what we can
do about it.